Bank of America: Could it fail and start another financial crisis?

Breaking the Bank

Bank of America: Could it fail and start another financial crisis?

While nobody was looking, America's largest bank approached the brink, tested the wind, lifted a foot, and started teetering. Well, to be fair, some people were looking. Wall Street has been worried about Bank of America for the better part of a year. Its stock price has declined from about $15 a share in January to a low of $6.01 this week, shedding nearly 30 percent of its value in the past month alone. There are rumors that JPMorgan will take it over. There are suggestions that Treasury Secretary Timothy Geithner should bail it out. There is talk of another credit crunch. Bank of America might just be the beginning.

All speculation aside, Bank of America is not in great shape. To meet its capital requirements, the bank has been forced to sell off good assets along with bad. Over the past year, it has shed more than a dozen divisions, including its profitable overseas credit-card operations, its Balboa insurance unit, a stake in the money manager BlackRock, and a mutual fund company.

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Moreover, after absorbing tens of billions of dollars in mortgage-related losses in the past three years, Bank of America faces tens of billions more. It has hundreds of thousands of delinquent mortgages and second loans on its books. The state attorneys general are working on a deal on the foreclosure fraud scandal that might cost it billions. Independent analysts estimate the bank faces $16.4 billion to $36.1 billion in further housing-related losses, both from delinquencies and litigation. No other bank is more exposed to the continuing woes of the housing market.

The bank itself admits the picture is not bright. "Obviously, the solid performance in our underlying businesses continues to be clouded by the costs we are absorbing from our legacy mortgage issues," Chief Executive Brian Moynihan wrote in a frank note reporting second-quarter losses last month. "We intend to continue our efforts to put the mortgage uncertainty behind us, build capital through the strength of the franchise, and deliver the returns for shareholders that we owe them."

That is hardly a rallying cry. And it is downright Pollyannaish compared with what some prominent analysts are saying about BofA.

In one corner sit the true pessimists: analysts who believe BofA's assets are worth far less than estimated, meaning the bank needs to sell new shares in a bearish market or keep heaving its best units overboard to stay afloat. Most vocal is Henry Blodget, building on work by influential financial bloggers Zero Hedge and Yves Smith. Blodget believes that BofA will exhaust its mortgage-litigation reserves and is overvaluing some housing-related portfolios to the tune of $200 billion. The concerns might be overblown. But the market is taking them seriously. The cost of insuring against BofA's default has gone through the roof. And investors are selling off BofA shares into a cratering market.

In the other corner sits a pool of analysts who believe that Bank of America remains stable, if weak. Richard Bove, a prominent analyst at Rochdale Securities, says BofA has "no reason whatsoever" to raise more capital. Meredith Whitney agrees that there is no crunch and recommends the bank keep writing down mortgage losses, selling units, and muddling through the foreclosure mess. All these "rosier" analyses point to Bank of America's cash reserves and cash flow as resources that should allow the bank to keep its bills paid and lights on.

On Tuesday, Bank of America stood up for itself, calling Blodget's analysis "exaggerated and unwarranted" and saying his numbers were off. The statement seems to have restored somemodicum of confidence, as shares bounced back 11 percent to $6.99 on Wednesday.

Unfortunately, this story is bigger than America's biggest bank. Bank of America is just the most badly bruised fruit in a rapidly rotting basket. When the recession ended, the entire banking sector rebounded, facing less competition and plenty of help from Uncle Sam (or is that Uncle Ben?). Many companies widened their profit margins. Some even saw record profits.

But the real economy never bounced back. Families never got back to buying big new houses. Consumers never got back to spending their money. Businesses never got back to hiring new workers. Companies never got back to investing in themselves. And when government spending started to taper, too—well, for a business in the business of lending money, there just wasn't enough to do. Banks cannot really make money in a world with 9.1 percent unemployment, Europe in crisis, the housing market in the tank, and sluggish growth. Banks are mostly still in the black, but earnings are rapidly declining.

It is not just Bank of America that Wall Street is getting bearish on. Wall Street is getting bearish on itself. Analysts have slashed profit estimates for retail and investment banks. And share prices have stumbled for many of them as well. Indeed, indices of banking stocks have fallen twice as much as the broader stock market. So worry about Bank of America—which, if it is not facing an immediate crisis, is still looking at a very difficult path to profitability. But worry more about the real economy and the banks that rely on it.

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